Clearing the (cap) table

Efficiency, efficiency, efficiency. You probably can't hear it anymore.

In the meantime, SaaS founders have either changed their strategy to be more efficient on their own initiative - or they have been urged to do so by investors.

The frontrunners continue to burn cash in a less wasteful way and have a good chance of getting more as they approach the end of their runway.

However, things look less promising for many others.

Their traction has never really been VC-compatible, or the transition to a more sustainable approach has led to a significant slowdown in growth.

Some of them now aim to become profitable in order to continue sustainably from there.

The big problem here is their VC legacy.

With growth rates of 10-30% yoy, it would take them 10+ years to grow into their last round’s valuation.

Or even worse, into a valuation that exceeds the amount of money raised.

Although founders' plans for a more “bootstrapper-like” approach are laudable, any potential exit proceeds are moving even further away.

In such situations, I think it makes sense to seek recapitalization right away.

A recapitalization (“recap”) in the context of VC-backed startups refers to a reset and clean up of the cap table. Usually, existing investors are washed out unless they put more money in. Anyone not relevant to the future success of the company may get removed too (old founders, ex-employees, etc.).

At the same time, it can be an opportunity for new shareholders to come in. It’s basically a restart and a makeup of equity owners.

In recent months, I had numerous conversations with founders and investors of startups who are standing in their own way - with false hopes and overly high expectations.

They actively look for options, but are not willing to pull the trigger. Always with the assumption that something better is yet to come.

Example:

• Startup raised a $10M series A in 2021 with $750k ARR and KPIs that would be far from sufficient today.

• Together with their seed, they raised a total of $13M.

• Last round’s post-money valuation was $60M.
  
  (Not making these figures up, see chart from Carta below)

• They just reached break-even at ~$2M ARR, the transition to greater efficiency has slowed growth to 30% yoy (note: this is below the rule of 40 line).

SaaS companies like these are currently trading at << 5x ARR.

You don't have to be a math professor to see that this would not lead to an attractive outcome for everyone involved.

The problem: It's not going to get any better in the near future. See my example assuming 20% yoy, 1x liqpref and a 3x ARR exit multiple.

If you carry on like this, you will have hands-off investors who are no longer committed (and may even have written off their investment).

On the other hand, there are founders who are still motivated, but are working for something they won't get anything out of in the next few years.

My conclusion from an investor's point of view would therefore be: Let's see what we can get out of it now, move on, and potentially reinvest the money.

And from a founder’s perspective: Let's clean up the cap table now in order to..

• Regain control,

• Restore shareholder alignment,

• Possibly bringing new partners on board, and

• Increase the chance of being sufficiently rewarded.

Both sides would be doing themselves a favor. Not only from a return perspective, but also for their peace of mind.

Disclaimer: The examples are simplified and may contain errors :-)